Nasdaq Sweats Through New 'Flash Freeze.' Should You?

There will be more market glitches, weather disruptions and flash crashes. Should it matter to you?

NEW YORK, NY - AUGUST 23: The Nasdaq stock market is viewed one day after the the electronic exchange experienced a a three-hour trading delay due to a technical problem on August 23, 2013 in New York City. Both Wall Street and Nasdaq were operating normally on Friday with stocks up slightly in afternoon trading.
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With Nasdaq's three-hour outage last month still fresh in many investors's minds another milder outage hit this week, and Wall Street is bracing for more possible market disruptions with the arrival of hurricane season. Last year's Superstorm Sandy led to the longest U.S. weather-related stock market shutdown since 1888.

It's the latest in a series of worrying breakdowns in the market's underlying infrastructure. "Flash" events – those wild swings or shutdowns spurred by a combination of volatile algorithmic trades and old-fashioned herd mentality – have rekindled fears of the market crash of 2008 and other financial calamities. But most of the one-day disruptions, either from weather or computers, end up having little lasting impact. The biggest danger for investors is to overreact to the scary headlines.

The latest NASDAQ OMX, which operates the Nasdaq exchanges, says there was "a six-minute outage" involving a data feed failure that was "promptly resolved." Such issues come at an inopportune time for the exchanges as the head of the Securities and Exchange Commission, Mary Jo White, has summoned stock exchange leaders to Washington next week to explain such outages, which she calls "serious." Keeping exchanges running, she says, is "critically important to the health of our financial system."

It's big news on Wall Street, to be sure, and professional traders who participate in the market are watching closely. But do average investors need to worry?

"Unfortunately, average investors who flip on the TV and hear that the Nasdaq is closing for three hours often freak out," says David Edwards, president of Heron Financial Group. "Some bail out of the market, and the problem is that if they do that, they bail out on their retirement, too."

[Read:12 Reasons Not to Fear a Market Bubble.]

The Nasdaq shutdown on August 22 made headline news and was quickly dubbed the "flash freeze," differentiating it from the much-debated "flash crash" that put stocks into a nosedive on May 6, 2010. Both came at about the same time of day, near 3 p.m., but they shared little else in common. In the freeze, trading came to a complete halt, and in the flash crash, stock prices tumbled 1,000 points, though trading continued and shares rebounded quickly.

But do such events mean the stock market's structure itself is dangerously brittle? Not necessarily, strategists say. Fran Kinniry, a principal at Vanguard Investment Strategy Group, says the fact that these events are newsworthy shows how unusual they are and, counterintuitively, how reliable the markets have become. There is always a chance of a market tumble, and there is rising uncertainty about the economy as the Federal Reserve gradually begins to pull back after five years of easy credit.

When the market hits one of its wild patches, it's never clear whether it's a temporary glitch or some fundamental problem. But at least by one key measure, the market is in a calm state: The VIX volatility index is now down 75 percent from its 2008 level to a level that is normal by historical standards. Indeed, short-term traders who like wilder market conditions complain that it's too quiet.

"The market has done an incredible job of being open as much as it is," Kinniry says. "With the recent 'freeze crash' or the big ['flash' crash] in 2010, if you did nothing, it was a non-event."

Investors who react too quickly can hurt themselves in flash events. "The best reaction for most people is to go about your normal business and activities and try not to react to these temporary situations," Kinniry says. The market, he adds, is "highly efficient," and when computer errors or shutdowns occur, the market usually corrects for the error.

[Read: The New Science Behind Stock Charts.]

"I always tell people the market shuts down every weekend for two days," Kinniry says. "And we come in on Monday and everything is okay."

Edwards, who has served on legislative and regulatory committees of the Investment Adviser Association, says, "You should not even notice something like this because you should have a five-year holding period for the stocks you buy." But he concedes that bigger investors have cause for alarm since a momentary crash or the inability to complete a trade could cost them millions of dollars. "This is really just an issue for institutional investors," Edwards adds. "You don't really need instant liquidity. You don't have that with your house or your job or anything else in your life."